Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
1. Who is in Control of the Markets These Days? Some have said the Fed. Yet we witness the Fed testing the Wall Street winds for the right way to proceed. Will it be more QE or less? Will the dollar be strong (as Geithner reminds us: we have a strong dollar policy … didn’t you know?) or weaken further? This week the dollar has attempted a rally on multiple occasions (each with a kneejerk move lower in gold and silver). While the dollar is likely to rally in the short term, we observe just how challenged it has been to move up with consistent strength. The announcement of QE, and the degree of monetary intervention, have little relevance to the long-term trend of the dollar, but may be a significant influence over the next 30-60 days.
Our long-term view is fundamentally driven. Balance sheet insolvency and a diminishment in revenues put the currency in a dangerous place. Short term, and on a strictly technical basis, the dollar has room for a modest move higher. Would 5-10% higher surprise us? Not really.
Reasoning for or against holding a dollar position is largely the difference between fundamental and technical analysis. We pay attention to both, but ultimately concede the priorities of fundamentals, and are therefore negative. So this is where we stand today. The dollar has been in a long-term decline (1913-present). This decline has accelerated since the closing of the gold window, and after a rise in the ’90s has reasserted the prior downside bias. Present tense, swirling around in various conversations, is the question of durability of the greenback – will it remain the world’s reserve currency or give up that distinguished position to a newcomer – or collective newcomers? We will see the dollar decline in value, but defeat and substitution will come with a fight. That will take time.
The answer is not just economic, not just monetary in nature. The durability of our currency regime is tied to the stature of our military, and the resolve with which we employ it. The dollar/fiat Ponzi scheme is in large part foisted on the world involuntarily. Our military strength and reach is a persuasive argument for participation in a dollar-centric regime. We will use that form of inducement more and more in the coming months and years. When argument fails, force will substitute, to the chagrin of the rest of the world. We are not destined to win any popularity contests any time soon.
The deflationary crowd will interpret this next move up in the dollar (assuming it can muster a rally) as the beginning of the end for stocks, gold, and commodities. We think this is the time when the wheat and chaff are separated, and while stocks may head lower with a disappointing QE lifeline, along with many commodities, gold will be treated more and more as the “senior currency.” It is real money, after all. The inclination to safety, and the growing distrust of institutions, including the U.S. and its globally distributed paper, will drive home the need for investor diversification into gold. With that comes the comfort of having more control of one’s financial future.
2. Time to Moderate the Rate of Inflation: This is no longer an “if” or a “maybe.” Inflation is here, and recent Fed policy and/or expectations of a massive QE2 are only serving to accelerate its growth – quite possibly allowing it to cascade out of control. This week we saw a tremendous amount of evidence leading to that conclusion:
• GDP figures posted Friday showed a real 2% growth rate for the 3rd quarter, with a 2.3% increase in the GDP price deflator – meaning more than half our country’s growth in the latest quarter is attributable to inflation.
• International commodity prices continue to rise at a faster pace than other assets, with copper, gold, and oil rising 16%, 8.1%, and 13% respectively, compared to the S&P which is up 10.44% and real estate which was down 5.9% since June.
• The Chicago purchasing managers’ index prices paid component rose to 68.9 from 55.0 in October – that’s a 25% increase in just one month!
• Soaring iron ore prices are harming steel producers’ margins.
• Grocers and McDonald’s have warned consumers that price hikes are coming due to soaring food costs.
• General Mills hiked prices on cereals and baking brands in the latest quarter.
• Kimberly Clark and Proctor and Gamble reported lower than expected earnings on weak consumer spending and higher raw material costs.
• 3M cut its profit forecast, saying full year earnings will be 6 cents lower than previously forecast.
• The Fed is contemplating changing its “inflation expectations” target based on TIPS spreads, with 5-year expectations rising 39% and the 10 year rising 43% (since the last Jackson Hole meeting).
All of this portends more inflation than the Fed may want at the moment, making doubtful the likelihood of a $1 trillion QE stimulus package as Goldman Sachs expects. This is at least the sentiment of the members of the G20 meeting last weekend, in which most everyone present except Tim Geithner called for moderating the currency war now afoot globally, with Germany and China taking center stage as our greatest critics. One Chinese commerce minister (Chen) is quoted as saying dollar printing is “out of control.”
If we continue at the current pace of dollar printing, the consequences are many, including:
• Escalating currency tensions/controls, tariffs, capital controls, and possibly trade wars.
• Risk to our exports as “beggar thy neighbor” dynamics emerge.
• Accelerated declines in U.S. GDP.
• Greater volatility and or market dislocations as GDP underperforms stock market returns (in the short run).
Again, I would like to clarify that we have two options in this credit crisis. We can either opt for outright bankruptcy or a delayed bankruptcy. But there is no escaping the inevitable. However, we do have a choice – or a privilege, if you will, as the reserve currency of the world, to postpone the verdict – by printing the right amount at the right times. This is hard to gauge, evidenced by the recent Fed survey of bond dealers for the answer. But if the markets are to be the judge at this point, they are telling us that we are out of balance in the quest for a more normalized economic level. A moderating of policy would help restore some semblance of normalcy to the relationships in the marketplace – at least temporarily. Then again, the Fed may also be held prisoner to recent gains in all markets, afraid to be the one to take away the punchbowl.
Have a wonderful weekend.
President and CEO
VP Investment Management